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January 28, 2013

Hussman, Last Bear Standing, Stands by Grim Predictions

The data-driven fund manager acknowledges discomfort of playing defense, but argues supply of greater fools is just about exhausted

John Hussman, a quasi prophet without honor in a market that refuses to heed his doomsaying forecasts, believes himself to be left alone with “permabears” and “nutcases” in his latest shareholder letter.

Known for his data-heavy and market-history-oriented analyses of current market conditions, the former finance professor once again explains why the market remains a ticking time bomb, and implies that the capitulation of other market skeptics may just confirm the end is nigh.

The eponymous manager of Hussman Funds cites Alan Abelson of Barron’s as an example of a levelheaded commentator who has capitulated to the current market mania, writing last week that investors remain invested in stocks “until they start to go the other way. After all, markets rarely fall out of a bed in one fell swoop as they did in 1987 and, more recently, the turn of the century, so there’s usually plenty of time to cut and run … we hope.”

Expressing the belief that Abelson is bound and gagged in a closet somewhere with someone else submitting articles in his name, Hussman (left) turns to his trademark data-rich analysis to warn of the danger of remaining invested in today’s market, thinking one can beat the rush to the exits.

Hussman cites just six historical instances where markets exhibited the set of conditions he identifies in today’s markets, and all ended disastrously.

Those conditions are overvalued and overbought stocks, together with overbullish sentiment and rising yields. Besides today, this combination of market conditions (for which he adduces technical indicators) occurred in 1929, 1972, 1987, 2000, 2007 and 2011.

Writes Hussman: “The market lost 85% between 1929-1932, lost over 50% between 1972-1974, crashed abruptly in 1987, lost over 50% in 2000-2002 and again between 2007-2009, and even lost nearly 20% in the less-memorable 2011 instance.”

The fund manager acknowledges John Maynard Keynes’ dictum that “the market can stay illogical longer than the investor can remain solvent,” but suggests that investors’ current bullishness is irrational and dangerous.

“Our defensiveness is certainly uncomfortable here,” he writes, “but in my view, the primary risk of investors is the intolerance of missed gains in a mature bull market, impatience with a defensive position, and capitulating against both discipline and evidence.”

In other words, Hussman implies that investors are acting in an extreme manner in seeking gains beyond what they have already recovered in previous market losses. He analyzes “the elephant in the room, which is the continued policy of quantitative easing by the Federal Reserve,” concluding that the record to data shows that monetary easing has worked to recover the market losses of the previous six months—not generate fresh gains.

Hussman, noting that as the monetary bases grows, the Fed must take increasingly large purchases to have an impact on stocks, concludes that what he calls QEternity will not save the market in the current round:

“With no prior 6-month losses to recover, it seems likely that other factors will exert a stronger effect on market returns going forward than if the Fed’s easing had been initiated in response to a major low,” he writes.

The market’s momentum has been based on the “greater fool” theory, whose logic Hussman embraces, with the caveat that “the supply of greater fools seems increasingly exhausted.”